Last week when we went through Montier’s criticism about shareholding value maximization, one thing we mentioned is “given the shortening lifespan of a corporate and the decreasing tenure of the CEO, many managers are willing to sacrifice long-term value for short-term gain”. The most fact that Monteir found is “declining and low rates of business investment.”
However, this week Tyler Cowen wrote an article to defend the short-termism.
First of all,
“Short-termism is said to plague all parties in the investment community, including investment managers, companies, and investors. However, it is very difficult to prove.”
However, a recent paper claims to “provide evidence of increasing short-termism in US equity capital markets over the period of 1980-2013, by using a ‘market discount factor’ estimated for publicly traded firms based on a capital asset pricing model”. (Which means it’s also a study for valuation.) They find that “markets more heavily discount firms that have less financial slack, spend less on capital or R&D, have greater analyst coverage, or held by more transient institutional investors as well as pay their executives via more short-term compensation.” And “short-term market valuations are significantly negatively correlated with future capital investment. “
However, Cowen argued that American corporations ought to be on short-term.
The following reasons are also combined with ideas from Michael J. Mauboussin’s report.
1. In information technology, betting on the future feels imprudent if change is rapid.
Academic research shows that the period of competitive advantage is shrinking for companies.
The world is speeding up. If the sustainability of a company’s economic profit is fleeting, there is less reason to place great value on the future. Planning so far out can involve a lot of expense and risk.
2. In information technology, the average life of a corporate asset is lowering.
“Production has shifted toward service sectors with relatively short asset lives, and that may call for a shorter-term orientation in response.”
Except rapid change, the more actual effect on investment comes from balance sheet, since shorter asset lives means higher depreciation.
-> So for many companies a contraction in time horizon is a proper response to economic reality.
And this is backed by “corporate governance tends to be better in sectors where asset lives are long than in sectors where asset lives are short. Where monitoring long-term investments is most relevant, corporate governance is the best developed. “
3. Companies tend to make big mistakes from thinking too big and too long-term
“for instance, a lot of mergers were based on notions of long-run synergies that never materialized.”
4. Given to high endurance of losing money by startups, investors are not ignoring the long-run prospects of the company.
“Amazon has a high share price even though its earnings reports have usually failed to show a profit .Many tech startups have high valuations even though revenue is zero or low.”
“During the dot-com bubble of the 1990s, there was too much long-run, pie-in-the-sky thinking and not enough focus on the concrete present.”
5. Compensation schemes for managers are more complex and more varied than in the past.
“Executive compensation has moved toward long-term incentives, boards of directors are more independent than in the past, and governance committees are “nearly universal.”
Moreover, a link between pay and short-termism is difficult to establish.
<- Academic research shows that CEO pay has closely followed the size of the firms in the economy independent of the form of remuneration.
6. Transient investors are not increasing.
And “while transient investors do take a short view, they are attracted to companies that provide lots of information events. It is these companies that appear most willing to trade value-creating investments to deliver short-term results.”
Anyway, “If public shareholders are placing too much short-term pressure on their companies for a good quarterly earnings report, companies have the option of boosting their value by going private, as has been the trend.”
<- By 2012, the number of U.S. public corporations was less than half what it had been in 1997, in part because many companies went private. See here.
Are U.S. Companies Too Short-Term Oriented? Some Thoughts Steve Kaplan University of Chicago Booth School of Business